If you are tired of the low interest rates offered on savings accounts and certificates of deposits, you may want to look at dividend paying stocks and mutual funds as an alternative. Stocks that pay a dividend can be a good alternative for investors who need to derive a solid income from their investment portfolios. Although there is risk in investing in the stock market, there is also risk in not earning enough return on your money. If you need to get a higher income that your bank is offering, you may want to make those dividend paying stocks and funds a part of your overall portfolio.
There are, however, some important things to keep in mind as you move your investments from savings accounts and CDs to dividend paying stocks and funds. One of the things you need to be aware of is that dividends are considered taxable income by the IRS. When you file your taxes, you are required to report the amount of dividend income you receive, and pay the applicable levy on the money you made.
Qualified vs. Ordinary Dividends
One of the most important distinctions to be aware of concerns the difference between qualified and ordinary dividends. This distinction can make a big difference in how big the tax bite is on your dividend portfolio, and that means you should take it into account as you build your income portfolio.
When you receive ordinary dividends, you are required to pay taxes on that money at your regular income tax rate. That means if your tax rate is 33 percent, you must pay 33 cents of each dollar you make in dividend income to the IRS. You simply add the amount of ordinary dividends you receive to your taxable income and use that figure to compute your tax bill.
Qualified dividends are different, and they are treated differently by the IRS. When you receive qualified dividends, you pay a maximum tax rate of 15 percent on that money. This is the same tax treatment used for long-term capital gains, and it can save you a lot of money, especially if you are in a high tax bracket.
When you evaluate dividend paying stocks and funds, it is a good idea to get a breakdown of the amount of ordinary dividends you can expect, as well as the amount of qualified dividends. You should be able to get that information from the brokerage firm where you have your stock market account, or from the investor relations department at the company you plan to invest in. While the breakdown of qualified vs. ordinary dividend is not the only factor you need to look at, it can be one of the most important.
